Contractors who resist the urge to hoard profits can reap big rewards by establishing a shared compensation arrangement
Amid-sized electrical contracting firm was on the constant lookout for a strong business development resource. Time and again, the CEO interviewed potential candidates, believing that a qualified resource should cost the firm no more than $50,000 a year with a small commission based on closed sales. While the idea of maintaining a low fixed salary was prudent for a business development position, the CEO added an additional wrinkle that immediately reduced the size of his candidate pool — he limited the upside compensation. So no matter how much revenue the employee generated, the cap for that particular position was $75,000 — the CEO's opinion of high-end compensation. Needless to say, the only candidates interested in applying were those who were either happy with the $50,000 base salary or those who exhibited no real hunger to be a top-level producer.
Does your electrical firm follow the practice of limiting the compensation of its employees, regardless of their contribution to the bottom line? As an owner, do you feel a sense of short-term entitlement that allows you to sweep the majority of firm profits into your pocket each year, leaving your staff to fight over meager bonus pools? If so, your firm could be heading for trouble — a brewing discontent that will push away productive employees and replace them with clock watchers.
Many electrical contracting firms follow the “caste” system of compensation where a select few employees — usually owners and a few key management types — receive the predominant share of operating profits, leaving the majority of workers to toil for their base salaries. This inequitable compensation-sharing arrangement eventually boils over into high levels of discontent, resulting in complacency. Employees work enough to keep their jobs, and owners are dismayed when employees choose life-balance philosophies over working a few hours of overtime. Fortunately, there is a solution that provides benefits to both the owner and employee — sharing the booty.
Breaking your business down
Shared compensation is based on recognizing the quantitative contributions of each employee. However, the expectations for contribution are dependent upon which segment of the organization the employee works. For example, if would be difficult to assign the same contribution measures to your marketing or business development person and bookkeeper. While both people are important to your operations, the expectations of each position are vastly different.
Most electrical contracting firms logically break their workforce down into the following business segments:
Sales and marketing — these employees are evaluated on revenue and profit generation (i.e., marketing or business development manager, sales manager).
Delivery and operations — these employees are evaluated on chargeable hours, customer feedback, and overall delivery excellence (i.e., electricians).
The sales and marketing solution
Finance and administration — these employees are evaluated on cost containment and increasing the corporate value of the enterprise (i.e., bookkeeper, office manager, purchasing clerk, human resources).
Each business segment must be viewed independently when crafting a shared compensation plan. Where most business owners salivate over sales success and high levels of chargeability, very often it is the bookkeeper that ensures the profitability of the firm. So, how can each individual share in your business' success?
Many owners of mid- to large-scale electrical contracting firms are stymied as to the parameters that should be in place for an effective shared compensation arrangement for sales professionals. Many believe in the commission-only philosophy while others, such as the CEO mentioned earlier, are more comfortable limiting any upside surprises. Remember, the goal of sales and marketing is to generate profitable work for your business. Don't make the mistake of providing bonuses to salespeople based on their level of activity (i.e., number of sales calls, participation in networking organizations). If these activities do not produce profitable work, they are of no value to you — the owner.
Let's look at a quick case in point. An electrical contracting firm located in Virginia was turning over its sales and marketing positions nearly every six months — much to the dismay of the owner. An examination of the problem revealed that while the compensation structure was adequate, the firm had never established effective value propositions for its service offerings. As a result, sales success was only achieved when the electrical contractor was the lowest price provider, wiping out any level of appreciable profit (and, in many instances, not fully recovering all of the firm's overhead costs). Although revenues were admirable, the sales resource did not benefit because shared compensation was calculated not only on revenue levels but also on profit contributions. Without any realized profit, there was no appreciable upside compensation.
In this case, the problem stemmed from the firm's sales and marketing philosophy. By not crafting effective value propositions, the firm was forced to sell its services using commodity pricing — a practice where low price wins. As bonus arrangements with sales professionals were based on both revenue and profit, talented individuals found themselves working hard but not obtaining any monetary benefit. In short order, these individuals moved on to greener pastures.
The goal of an effective shared compensation arrangement for sales and marketing professionals is to establish a structure that rewards both revenue and profit contributions. This way, sales professionals are focused on bringing “good” work to the business — not just any work. In addition, as related in the story at the beginning of this article, a business owner should never “cap” an employee's potential earnings — to do so limits their ambition and reduces your upside corporate growth.
The operational solution
Finding a shared compensation solution for the operations and delivery component of your firm is a straightforward process. Owners of electrical contracting firms can easily assess the productivity of their electricians — literally measuring the per customer revenue that is generated for a stated period. As with sales, the goal is to measure the profitable contribution of each employee — not just the chargeable hours. To reward just the hours worked without recognizing the real monetary contribution is missing the real value contribution.
Falling further behind on its delivery promises, one mid-sized electrical contracting firm in New York is a good example of how this mind-set can backfire. The CEO, who was also the lead business development person, was constantly looking for new customer opportunities. He literally spent every day beating the bushes for new work. Once he found it, he said “yes” to every possible opportunity — regardless of the project's profitability. Unfortunately, delivery personnel were going out of their minds as new and different jobs continued to appear, and the customer work list continued to grow. In time, deadlines were missed, and high levels of re-work became necessary as delivery personnel tried to cut corners to clear customer projects. Finally, completely worn out, delivery people started to leave.
In this case, a shared compensation arrangement based solely on hours worked would have been disastrous. The electricians were working hard but not effectively. As levels of re-work and customer complaints increased, the profitability of each job disappeared. Because the profitability of each job was suspect, it was difficult to determine which hours worked were realizing any real quantitative contribution.
In a perfect pricing environment, each employee should generate gross revenues that equal approximately three times their cost (salary and benefits). As an example, a an electrician who makes $50,000 a year with a 20% benefits component should generate approximately $180,000 in gross revenues for the firm. Under this scenario, a rationale charge rate for this employee would be approximately $100 an hour — assuming an 1,800 chargeable year target. However, because many projects are bid based on fixed hours, a more competent employee may complete the job in less time than bid yielding a far higher level of profitability on the project. This, of course, is contrasted with another employee who works more hours to complete the job, thereby reducing the profit contribution to the firm.
The administrative solution
Finance and administration is an area where a shared compensation plan has always been difficult to develop, as these employees are not viewed to have a direct impact on either revenue or profitability. Companies typically provide modest cost-of-living adjustments (COLA) to these employees — more as a way to reward longevity as opposed to any monetary contribution. This is not always the best approach, because administrative personnel have more of an impact on your profitability than you might think.
For example, an electrical contracting firm was seeking to implement a comprehensive compensation sharing plan with all of its employees — including the bookkeeper. As administrative costs continued to climb each and every year (increased health insurance premiums, higher energy costs to heat the building and fuel the trucks, and more complex telephone requirements), the owner came upon a perfect way to measure the bookkeeper's performance — reduce the overall administrative costs of the business as a percentage relationship to labor dollars spent. In other words, prior to implementing this metric of performance, the electrical contracting firm was spending approximately 30 cents of every dollar billed on administrative (or indirect) charges. The bookkeeper's goal was to reduce this expense, thereby spreading a lower administrative cost burden across the organizational revenue. After the first year, she was successful in dropping it down to 24 cents per dollar earned — a savings of 20%! Her shared compensation amount was based on a percentage of the dollars the firm saved.
For owners of electrical contracting firms, it's important to remember that every employee has an impact on firm value — even the forgotten administrative personnel. For many companies, the bookkeeper is the employee with the most tenure (a logical assumption if it is your spouse!).
The three-tiered compensation approach
Should you reward an exemplary employee even though the firm lost money for the year? Cash flow logic suggests that paying out any bonuses in a down financial period further risks the cash reserves of your firm. Conversely, punishing an employee who has exceeded his or her performance metrics sends another less attractive message — specifically, the firm has let you down. The answer may actually be a compromise that ensures good employees obtain some reward but not to the complete detriment of the firm. Enter the three-tiered compensation approach, which examines upside bonuses based on the performance of the following: the individual, the business unit, and the corporation.
To illustrate this approach, let's say a large electrical contracting firm had two divisions — a residential and commercial business. The employees were assigned to a specific division by the owners, and rarely did an employee work for both divisions simultaneously. The firm followed the three-tier approach where bonuses were calculated equally based on the success of the individual, the division, and the entire firm. In 2007, it was not unusual for employees in the residential division to only receive 66% of their bonus allotment — 33% for individual performance, 33% for overall firm performance, and 0% for the performance of the residential division. For this firm, exemplary employees were still rewarded — recognition that they achieved their objectives — even though the firm, as a whole, may have come up short.
Contrast this approach with a smaller firm — also located in the same geographic area. The owner, ever mindful of his bottom line, took the approach to cancel all compensation sharing arrangements when his firm suffered an operating loss for the year. While this reaction was prudent from the owner's perspective, it had negative connotations to those employees who had “busted their humps” that year. Not surprisingly, the firm's two top electricians resigned soon after the end of the year.
In general, employees should be rewarded for those activities that are under their control and not be punished for the actions of others in the corporation.
Owners of electrical contracting firms are always suspect of implementing a shared compensation arrangement. Many argue that such a process reduces their personal take-home compensation or unfairly rewards “lucky” customer situations where an employee just happened to be at the right place at the right time (see Luck of the Draw on page C22).
One reason is because the workforce is changing. Today, where terms such as “work-life balance” have entered the lexicon, owners are finding it more difficult to attract and retain employees with a real drive to succeed. Gone are the days when electricians joined an electrical contracting firm and were driven to maximize chargeable hours and reap larger monetary rewards. Those employees will find employment elsewhere nowadays.
Because of the competitive job market, downturn in economy, and labor shortage in the electrical industry, owners may want to take a second look at the benefits of implementing a shared compensation plan. Beyond ensuring a productive environment for driven employees, it provides you, the business owner, with ever-increasing corporate value — the real measure of your success and, for many owners of electrical contracting firms, your retirement.
Dawson is managing director of LTV Dynamics, an international sales management and business consulting firm in the suburbs of Washington, D.C. He can be reached at BLDawson@LTVdynamics.com.
Sidebar: Luck of the Draw
Sometimes, you're just in the right place at the right time. A junior electrician who had accepted a position at an electrical contracting firm learned this lesson firsthand. Little did he know that his rather impressive network of contacts (thanks to his new wife's family connections) would pay off big time.
As had been its practice for many years, the firm provided a 10% bonus to any employee that brought new work into the company. After only a couple of months, the electrician “lucked” into a connection that yielded a $1 million project — an amount that was approximately one-third the annual revenue of the firm. At first, the owner of the firm was hesitant to pay out the $100,000 bonus due to this new employee — an amount that was far more than the electrician's current annual compensation. However, after much reflection, he realized that the revenue associated with this new customer had substantially increased the corporate value of his firm, making the $100,000 payout a reasonable business development expense.